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Fitch Downgrades XLCA to Junk Status

Fitch Ratings yesterday downgraded XL Capital Assurance Inc. to junk status, dropping the insurer financial strength rating to BB from A, and moving the financial guarantor to negative outlook.

The downgrade reflects Fitch's assessment of XLCA's capital position, the company's plans for raising additional capital, an update of the exposure of XL to subprime-related mortgages, and the "material erosion" of the franchise and business value for XL Capital, which is owned by Security Capital Assurance Ltd. Earlier this month, SCA announced that it would temporarily cease writing new business to preserve capital.

"Fitch believes that SCA's current level of capital and claims paying resources is no longer consistent with Fitch's guidelines for an investment grade IFS rating," the rating agency said in a release.

Expected losses on structured finance collateralized debt obligations are likely to reach $3 billion to $4 billion, compared with SCA's modeled claims paying resources and reinsurance coverage of $4.2 billion at the end of last year, Fitch said. The rating agency noted that the company would likely not have to pay a majority of its claims, especially those for the CDOs, for several years.

The bond insurer is involved in a dispute with Merrill Lynch International over seven credit default swap contracts that SCA recently canceled. Merrill Lynch has brought suit and though Fitch said a SCA win in the dispute could have a positive effect on the bond insurer's books, it is likely to be several years before it is settled, Fitch said.

XL Capital has guaranteed three deals this year, with a total par value of $35.6 million, making it the seventh-busiest insurer in 2008, according to data from Thomson Financial. Earlier yesterday, XL Capital provided the insurance on a $56.40 million portion of the $337.1 million revenue refunding bonds for the Dallas Fort Worth International Airport.

SCA yesterday announced it would cut 60 positions, primarily in the insurance origination business, to reduce operating costs.

Also yesterday, Fitch downgraded Financial Guaranty Insurance Co.'s insurance financial strength rating to BBB, from AA, and placed it on negative outlook.

Both downgrades are likely to cause problems for issuers with variable rate demand obligation exposure. Many termination events for liquidity facilities on such deals are tied to the downgrade of an insurer to a rating below investment grade, though.

"It would be important to look at the resolutions on the VRDNs to see if this triggers an event allowing the liquidity facility provider to step aside," said Peter Delahunt, national institutional sales manager at Raymond James & Associates Inc. "However, the VRDN resolutions are not uniform and each one is unique in their language like fingerprints and snowflakes."

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